Company Law Memo

Shashwat Jindal

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Memo Problem:!
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Arvind, Yogi and Manish set up a company called Aap-Apps Private Limited (Company) on
May 15, 2014, with the object of developing mobile applications, for third parties. Arvind is a
graphic designer and Yogi is a computer programmer, and they have been friends from their
years together in school. Over one of their many casual conversations, they struck upon the
idea of setting up a company that would create mobile applications for businesses; and not long
after that conversation, they quit their respective jobs and decided to start their business.
However, they realized that they would not be able to pool together sufficient resources; and
therefore, invited their third friend, Manish, an investment manager, to also join their business.
Manish agreed, and accordingly, the Company was set up. Each of them invested INR
10,00,000, which was divided into 1,00,000 equity shares of INR 10 each. Arvind, Yogi and
Manish appointed themselves as directors on the board of the Company.!
They worked hard to draw clients and the Company was in early 2015, awarded a contract to
develop a mobile application for ICICI Bank. Its clientele grew increasingly impressive from
there and soon, it was drawing more work than they could handle. They realized that the
Company needed to hire more people, which in turn, meant that it would need a bigger space
for its Mumbai office. They also, then discussed the possibility of opening an office in Bangalore,
which is where a lot of their clients were based. Expansion of this scale however, needed
additional funds; and so, Manish proposed that each of them invest an additional INR
20,00,000, to which Arvind immediately agreed. Yogi however, rejected the suggestion because
he did not think he would be able to afford such a huge sum. He suggested instead, that they
seek an institutional investor willing to invest a sum of INR 60,00,000. Arvind and Manish
however, were concerned that it would lead to a dilution in their control over the management of
the Company and were of the opinion that at least for the moment, they should desist from
inviting an institutional investor on board. Thus, despite Yogis objections, Arvind and Manish
passed a board resolution for a rights issue of INR 60,00,000. The resolution authorized Manish
to, on behalf of the Company, send a notice to each of the three shareholders offering each of
them 2,00,000 shares of INR 10, and giving them a time period of 20 days from the date of
receiving the offer, to accept it. Not unexpectedly, Yogi could not accept the offer within this
period, despite his many efforts to arrange the necessary funds to exercise his option to
purchase the shares offered. The Articles of Association of the Company did not permit the
shareholders to renounce their right under Section 62(1)(a) of the Companies Act, 2013 in
favour of another person; and accordingly, it fell upon the Board to decide how to dispose the
additional 2,00,000 shares. !
Arvind and Manish, at the next meeting of the Board, decided on a preferential allotment of the
remaining shares and a resolution was passed that authorized Manish to identify suitable
persons to whom these shares may be issued. This time around, Arvind and Manish were less
concerned, about introducing new members in the Company, because at the end of the
allotment, they would hold more than 66 percent of the shares of the Company, and the shares
that would be allotted to the new member(s) would carry only around 22 percent of the total
voting rights. At the same time, however, Manish was aware that the sum involved was too
small to draw an institutional investor; and therefore, decided to offer these shares to people
among his family and friends. !
Manish then, called some of their friends enquiring whether they would be interested in
investing in the Company. After making around 15 unsuccessful such calls, Manish put up a
status message on Facebook saying, Hoping to expand our office in Mumbai, and set up a new

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Company Law Memo

Shashwat Jindal

one in Bangalore; that is, assuming we manage to put together the necessary funds. So, if you
have some loose change lying around the house, send it our way! On a more serious note, if
you (or someone you know) is interested in investing a small sum in our Company, let me know
and Ill be in touch. The post also carried a link to the website of the Company. Of his nearly
500 friends on Facebook, only around 10 responded, and eventually, the Board allotted 20,000
shares of INR 10 to each of these 10 friends of Manish.!
Meanwhile, Yogi was naturally furious at having been reduced to a mere 11% in the Company.
He also thinks that the allotment to Manishs friends compromises on the need to maintain
confidentiality regarding their business. He approaches you and seeks your advice on whether
the allotment to Manishs friends is invalid for being contrary to his and the Companys interest.
He also, wishes to know whether there is ground to argue that the allotment of shares to
Manishs friends was contrary to Section 42 of the Companies Act, 2013 (and Rule 14 of the
Companies (Prospectus and Allotment of Securities) Rules, 2014). !

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Facts:!
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In the present case, the petitioner, Yogi and the respondents, Arvind and Manish, set up a
Private Limited Company, which created mobile based applications for mobile phones. As the
business was growing, they decided that the company needed more funds, so that they could
expand both their present office and open new offices. Contrary to the appellants previous
suggestion to get an institutional investor to invest an additional Rs. 60,00,000, it was decided
through a board resolution that each one of the owners would invest an additional Rs. 20,00,000
each into the company. The appellant was unable to arrange the said amount and thus it was
decided by the board that shares would be allotted through preferential allotment. As they could
not find any suitable investors, Manish finally put up a status on Facebook, which could be
viewed by his 500 friends on Facebook, to invest in the company, it also had a link to the
website of the Company. Out of the 500 friends, only 10 responded, who invested money into
the company. !
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Issue:!

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Whether the board was authorized to pass a resolution as to how the shares were to be allotted.!
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Whether a Private Limited Company, the investment made by the 10 persons is valid on
account of the company being a Private Limited Company. !

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Analysis:!
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According to Section 107 of the Companies Act, decisions of the Company are to be taken
through voting, which is usually a raise of hands, where the decision of the majority is taken into
consideration. Thus, in this Company of 3 people, the respondents could have taken the
decision to not go for institutional investor. !

According to Section 62(1)(a), the shareholders, i.e. in this case, the appellants and the two
respondents, were given time period of 20 days to accept the offer, which fulfilled the condition
of minimum of 15 days to be given to equity holders in the company, after which the choice of

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Company Law Memo

Shashwat Jindal

how the shares are to be disposed off is given to the board (Section 62(1)(c)), thus giving the
board the right to dispose the shares as per their wishes. Also, Section 62 of the Act, which
gives a Pre-emptive right to existing shareholders, was not violated in this case, as an offer had
been made to the appellant.!

According to section 42 of the companies Act, in the case of private placement, not more than
50 people can in one issue be invited to subscribe to the shares of the company through private
placement. Section 2(68)(iii) of the Companies Act 2013, says that a Private Limited Company,
is prohibited from inviting general public to subscribe to the shares of the Company. The only
way for a Private Limited Company to raise share capital is through private placement.
According to the case of Sahara India Real Estate Corporation Limited (SIRECL) vs SEBI, the
learned Supreme Court was of the opinion that as the offer to invest in the company was to
more than 50 persons. In the present case, Manish had made an offer to the 500 people on his
Facebook, to invest in the company, the offer had been made to more than 50 persons, thus
violating the basic principal that a Private Limited Company cannot make a public offer, thus
invalidating the purchase of shares by the ten friends of Manish. !

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Conclusion:!
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Thus, it may be concluded that, though the Board of Directors, had the right to allot the
remaining 200000 shares as per their desire, but the method, which was followed by them, was
not right as they had made a Public offer, even though they were a Private Limited Company.

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